Having spent some time on end-of-calendar-year investment portfolio housekeeping and calculating your returns for the year, you will no doubt be pleased at the performance of your portfolios. 2019 was a great year for investors.
This article originally appeared in The Australian on 24 January 2020
But how did you really go? What are the correct calculations to do? What benchmarks are the appropriate comparators?
In my years of advisory and consulting practice I have often encountered comments such as we did very well in our portfolios over a given time period accompanied by the complete inability to answer the next, probably more important question — compared to what?
As investors, we all make an explicit or implicit choice to be active or passive investors in each asset class.
Passive investors choose to invest in the whole asset class as represented by a particular index such as the ASX 200 in Australian shares. Choosing “passive” will deliver the return from the index — all 200 shares in that case — minus a small fee for the product provider. There is little need to ask the question how did you go? There will be neither luck or skill involved. The outcome will be I got what the market got less a smidge for fees.
But most of us are still “active” investors in part if not for our whole portfolios. We make active security selections, participate in capital raisings, invest with active fund managers or select investments that are not in any index.
The outcomes of these selections will be different to any market-constructed index and the comparison will be informative.
For example, if you invested in equity markets during 2019 you would compare your results with the relevant markets in which you were invested. There are a range of widely accepted and followed market indexes issued by credible and respected market providers.
Most published index returns are price movements only, so again it’s important to be comparing apples with apples.
One exception is the Australian All Ordinaries Accumulation Index, which incorporates dividends as well as price movements. You can see from this just how important dividends are as part of total return for equity investors — over 10 years the total return for All Ordinaries investors is nearly three times the price-only return.
Exercise caution here on the significant impact franking credits have for Australian equity investors, too — franking credits can add 1-2 per cent to the after-tax return for Australian equity investors but are not included in the conventional indexes.
Which index should I choose as the appropriate comparator?
The answer is the one that most closely resembles your underlying portfolio. The All Ords, for example, reflects the 500 largest listed stocks. Other commonly used measures are the ASX 300, the ASX 200, the ASX 100, the ASX 50, the Small Ordinaries (companies in the ASX 300 but excluding the ASX 100) and the MicroCaps (companies ranked between 350 and 600 by market capitalisation).
Other available indexes that may be appropriate comparators are sector-specific at a high level such as ASX Industrials and ASX Resources. Investors who specifically exclude resource stocks from their portfolio might find this index a useful one to consider when evaluating that exclusion decision.
Some investors have very concentrated portfolios, say with only a handful of stocks, and they may be best served comparing the performance of their portfolio with a sector index that reflects those underlying stocks.
Last year, for example, saw the healthcare sector strongly outperform all other sectors and the banks underperform all other sectors. Investors with portfolios concentrated on either of those sectors would have results vastly different to the All Ordinaries.
Most other asset classes besides equities also have widely accepted indexes that you can use to assess the performance of your portfolios — unlisted property, bonds, credit, hybrids, cash and alternatives all have established indexes available.
If you are an advised investor, your advisers will prepare a customised appropriate comparator performance calculation for you to discuss in your next review meeting. If you are a self-directed investor you may need to do the hard work yourself.
Or as a proxy you can use the higher-level aggregate performance benchmarks published by the agencies that monitor and tabulate the performance of the countries’ largest super funds.
My experience working in investments for superannuation, not-for-profits, philanthropy and private wealth is that there are numerous lenses to the “how did we go?” question.
Benchmark comparisons have their place, as do peer comparisons, but the more long-term and self-accountable the investor is, I have found, the more fixed or floating objectives or targets become the prevailing benchmark rather than market or peer comparisons.
For example, cash plus 5 per cent or CPI plus 5 per cent might be a long-term objective or target for an investor who cares less about what others are doing or thinking.
Whatever your target or objective is, it pays to keep it front of mind and to remember not to judge a fish by its ability to climb a tree.